230B: Public Economics Capital Taxation Emmanuel Saez Berkeley 1
MOTIVATION 1) Capital income is about 25% of national income (labor income is 75%) but distribution of capital income is much more unequal than labor income Capital income inequality is due to differences in savings be- havior but also inheritances received ⇒ Equity suggests it should be taxed more than labor 2) Capital Accumulation correlated strongly with growth [al- though causality link is not obvious] and capital accumulation might be sensitive to the net-of-tax return. ⇒ Efficiency cost of capital taxation might be high. 2
MOTIVATION 3) Capital more mobile internationally than labor Key distinction is residence vs. source base capital taxation: Residence: Capital income tax based on residence of owner of capital. Most individual income tax systems are residence based (with credits for taxes paid abroad) Incidence falls on owner ⇒ can only escape tax through evasion (tax heavens) or changing residence (mobility of persons) Tax evasion of capital income through tax heavens is a very serious concern (Zucman QJE’13, ’15) 3
Source: Capital income tax based on location of capital (most corporate income tax systems are source based) Incidence is then partly shifted to labor if capital is mobile. Example: Open economy with fully mobile capital and source taxation: Local GDP: wL + rK = F ( K, L ) = L · F ( K/L, 1) = L · f ( k ) where k = K/L is capital stock per worker Net-of-tax rate of return is fixed by the international rate of return r ∗ so that (1 − τ c ) F K ( K, L ) = (1 − τ c ) f ′ ( k ) = r ∗ where k = K/L is capital stock per worker and τ c corp tax rate As wL + r ∗ K = F ( K, L ), wage w = F L ( K, L ) = f ( k ) − r ∗ · k falls with τ c 4) Capital taxation is extremely complex and provides many tax avoidance opportunities
MACRO FRAMEWORK Constant return to scale aggregate production: Y = F ( K, L ) = rK + wL = output = income K = capital stock (wealth), L = labor input r = rate of return on capital, w is wage rate rK = capital income, wL = labor income α = rK/Y = capital income share (constant α when F ( K, L ) = K α L 1 − α Cobb-Douglas), α ≃ 30% β = K/Y = wealth to annual income ratio, β ≃ 4 − 6 r = ( rK/Y ) · ( Y/K ) = α/β , r = 5 − 6% 4
Figure 12: Capital shares in factor-price national income 1975-2010 40% 35% 30% 25% 20% USA Japan Germany 15% France UK Canada Australia Italy 10% 1975 1980 1985 1990 1995 2000 2005 2010 Source: Piketty and Zucman (2014) 43
Private wealth / national income ratios, 1970-2010 800% USA Japan 700% Germany France UK Italy 600% Canada Australia 500% 400% 300% 200% 100% 1970 1975 1980 1985 1990 1995 2000 2005 2010 Authors' computations using country national accounts. Private wealth = non-financial assets + financial assets - financial liabilities (household & non-profit sectors) Source: Piketty and Zucman '13
Private wealth / national income ratios 1870-2010 800% 700% USA 600% Europe 500% 400% 300% 200% 100% 1870 1890 1910 1930 1950 1970 1990 2010 Authors' computations using country national accounts. Private wealth = non-financial assets + financial assets - financial liabilities (household & non-profit sectors) Source: Piketty and Zucman '13
The changing nature of national wealth, UK 1700-2010 800% 700% Net foreign assets Other domestic capital 600% Housing Agricultural land (% national income) 500% 400% 300% 200% 100% 0% 1700 1750 1810 1850 1880 1910 1920 1950 1970 1990 2010 National wealth = agricultural land + housing + other domestic capital goods + net foreign assets Source: Piketty, Handbook chapter, 2014
The changing nature of national wealth, France 1700-2010 800% 700% Net foreign assets Other domestic capital 600% Housing Agricultural land (% national income) 500% 400% 300% 200% 100% 0% 1700 1750 1780 1810 1850 1880 1910 1920 1950 1970 1990 2010 National wealth = agricultural land + housing + other domestic capital goods + net foreign assets Source: Piketty, Handbook chapter, 2014
The changing nature of national wealth, US 1770-2010 (incl. slaves) 600% Net foreign assets Other domestic capital Housing 500% Slaves Agricultural land 400% (% national income) 300% 200% 100% 0% 1770 1810 1850 1880 1910 1920 1930 1950 1970 1990 2010 National wealth = agricultural land + housing + other domestic capital goods + net foreign assets Source: Piketty and Zucman '13
Piketty (2014) book: Capital in the 21st Century Analyzes income, wealth, inheritance data over the long-run: 1) Growth rate n + g = population growth + growth per capita. Population growth will converge to zero, growth per capita for frontier economies is modest (1%) ⇒ long-run g ≃ 1% , n ≃ 0% 2) Long-run steady-state Wealth to income ratio ( β ) = savings rate ( s ) / annual growth ( n + g ): β = s/ ( n + g ) Proof: K t +1 = (1+ n + g ) · K t = K t + s · Y t ⇒ K t /Y t = s/ ( n + g ) With s = 8% and n + g = 2%, β = 400% but with s = 8% and n + g = 1%, β = 800% ⇒ Wealth will become important 6
Piketty (2014) book: Capital in the 21st Century 3) After-tax rate of return on wealth ¯ r = r (1 − τ K ) = 4 − 5% significantly larger than n + g [except exceptional period of 1930–1970] With ¯ r > n + g , role of inheritance in wealth and wealth con- centration become large [past swallows the future] Explanation: Rentier who saves all his return on wealth ac- cumulates wealth at rate ¯ r bigger than n + g and hence his wealth grows relative to the size of the economy. The bigger ¯ r − ( n + g ), the easier it is for wealth to “snowball” ⇒ Capital taxation reduces r to ¯ r = r · (1 − τ K ) ⇒ This can reduce wealth concentration 7
Figure 10.10. After tax rate of return vs. growth rate at the world level, from Antiquity until 2100 6% 5% nual rate of return or rate of growth 4% Pure rate of return to capital (after tax and capital losses) 3% Growth rate of world output g 2% Annual ra 1% 0% 0-1000 1000-1500 1500-1700 1700-1820 1820-1913 1913-1950 1950-2012 2012-2050 2050-2100 The rate of return to capital (after tax and capital losses) fell below the growth rate during the 20th century, and may again surpass it in the 21st century. Sources and series : see piketty.pse.ens.fr/capital21c Source: Piketty (2014)
WEALTH AND CAPITAL INCOME IN AGGREGATE Definition: Capital Income = Returns from Wealth Holdings Aggregate US Personal Wealth ≃ 4*GDP ≃ $60 Tr Tangible assets: residential real estate (land+buildings) [in- come = rents] and unincorporated business + farm assets [income = profits] Financial assets: corporate stock [income = dividends + re- tained earnings], fixed claim assets (corporate and govt bonds, bank accounts) [income = interest] Liabilities: Mortgage debt, Student loans, Consumer credit debt Substantial amount of financial wealth is held indirectly through: pension funds [DB+DC], mutual funds, insurance reserves 9
Source: Saez and Zucman (2014) The composition of household wealth in the U.S., 1913-2013 500% 400% % of national income Pensions 300% Equities Currency, deposits and bonds 200% Sole proprietorships & partnerships 100% Housing (net of mortgages) 0% 1913 1918 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013
Source: Saez and Zucman (2014) The composition of capital income in the U.S., 1913-2013 35% 30% % of factor-price national income 25% Profits & interest paid to pensions 20% 15% Corporate profits Net interest 10% Noncorporate business profits 5% Housing rents (net of mortgages) 0% 1913 1918 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013
INDIVIDUAL WEALTH AND CAPITAL INCOME Wealth = W , Return = r , Capital Income = rW W t = W t − 1 + r t W t − 1 + E t + I t − C t where W t is wealth at age t , C t is consumption, E t labor in- come earnings (net of taxes), r t is the average (net) rate of return on investments and I t net inheritances (gifts received and bequests minus gifts given). Replacing W t − 1 and so on, we obtain the following expression (assuming initial wealth W 0 is zero): t t � � W t = ( E k − C k + I k ) (1 + r j ) k =1 j = k +1 11
INDIVIDUAL WEALTH AND CAPITAL INCOME t t t t � � � � W t = ( E k − C k ) (1 + r j ) + (1 + r j ) I k k =1 j = k +1 k =1 j = k +1 1st term is life-cycle wealth, 2nd term is inheritance wealth Differences in Wealth and Capital income due to: 1) Age 2) past earnings, and past saving behavior E t − C t [life cycle wealth] 3) Net Inheritances received I t [transfer wealth] 4) Rates of return r t [details in Davies-Shorrocks ’00, Handbook chapter] 12
WEALTH DISTRIBUTION Wealth inequality is very large (much larger than labor income) US Household Wealth is divided 1/3,1/3,1/3 for the top 1%, the next 9%, and the bottom 90% [bottom 1/2 households hold almost no wealth] Financial wealth is more unequally distributed than (net) real estate wealth Share of real estate wealth falls at the top of the wealth dis- tribution Growth of private pensions [such as 401(k) plans] has “de- mocratized” stock ownership in the US US public underestimates extent of wealth inequality and thinks the ideal wealth distribution should be a lot less unequal [Norton- Ariely ’11] 13
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